China Syndrome: A Wilting Economy, Financial ‘Long-Covid’, a Collapsing Property Sector — and the Spectre of Deflation Hovering Nearby

The global economy is supported by four pillars; two are wobbly, reports Wim Romeijn, and one is being rebuilt. The first in a series of four CFI.co investigations…

The world’s major economies are facing up to an era beset by war, climate change, and shifting power blocs.

In Germany, inflation refuses to budge, and the economy refuses to grow. Infrastructure is crumbling, and car manufacturers are struggling to deal with the electric vehicle revolution.

In Japan, a weakened currency has lifted morale and rekindled economic growth. A turning point seems near as the “lost decade” draws to a close.

The United States, meanwhile, is doing rather well, with 2023 GDP growth expected to come in at a comparatively robust 2.4 per cent or higher. The job market is also proving resilient, shrugging off repeated interest rate hikes. Businesses and households continue to spend whilst inflation was slashed to three percent — within striking range of the Fed’s two-percent target.

China Syndrome

In China, however, the expected post-lockdown surge has failed to materialise. The property market has collapsed, taking with it some of the country’s biggest developers.

What goes up doesn’t necessarily come down. The last time China’s GDP contracted was in 1976, by 1.57 percent. It was the year Mao Zedong and Zhou Enlai died, the Cultural Revolution collapsed with the denunciation and purge of the Gang of Four, and reformer Deng Xiaoping began his rise to the top.

Since those chaotic days, a national recession hints at a slower pace of growth. Last year, economic activity increased by just 2.99 percent in the wake of enduring Covid lockdowns.

Market analysts and observers have been predicting an economic meltdown — a China Syndrome of sorts. Without dependable data, the doomsayers are scouting for signs that could confirm their fears. They point to the weak housing market and mounting troubles for developers such as Evergrande, Country Garden, and Sino-Ocean. All are facing financial difficulties, missing coupon payments, or pleading with bondholders for better terms.

No Jobs for the Young

Youth unemployment stands at 20 percent. CEOs of Western companies with a presence in China detect a lack of confidence — which keeps consumers from spending and businesses from investing. The spectre of deflation hovers nearby.

International concern about China’s predicament is understandable: a recession there would reverberate around the world. In some quarters, the language employed by China-watchers is emotive: a “ticking time-bomb”, a “Lehman moment”, “imminent Japanification” and “economic long-Covid”.

Observers less given to hyperbole are equally worried. They point to President Xi Jinping’s “meddlesome” rule and his apparent inability to pacify the Americans. On a recent four-day visit to Beijing, US Commerce Secretary Gina Raimondo urged the leadership to reduce business risk, and warned that American companies are beginning to see China as “uninvestable”.

US Secretary of State Antony Blinken and Treasury Secretary Janet Yellen are also recent visitors to Beijing, recently to assure leaders there that America is not “’decoupling” and would prefer to stabilise relations.

This is not necessarily how things appear from Beijing; President Joe Biden has signed an executive order restricting US investment in Chinese semiconductor, quantum computing, and AI companies.

Zero Covid / Confidence

As China’s draconian “zero-Covid” policies were lifted, most analysts expected a release of pent-up demand. Forecasters expected GDP to jump by six percent this year. The current target stands around five percent, allowing the government some wriggle-room. The reality is harsher still: GDP is slated to advance by just three percent — or less.

The post-Covid splurge was short-lived and petered out almost as soon as it began. The gloom visited upon the Chinese during the pandemic was severe. Lockdowns forced consumer confidence from a high of 127 at the start to a low of 86 towards the end (100 represents equilibrium between optimism and pessimism). Confidence hasn’t snapped back since. In an authoritarian regime, bad news calls for suppression. China’s National Bureau of Statistics simply stopped publishing figures on youth unemployment and consumer confidence.

FDI in Q2 was down a staggering 87 percent year-on-year. The adage that the Party won’t bother entrepreneurs and investors if they don’t bother the Party no longer holds true. President Jinping tends to micromanage the economy (and society), and has introduced a measure of uncertainty.

It can no longer be assumed that the Chinese economy will keep growing. It’s on a downward trajectory in dollar terms; deflation and a weakening currency have wiped trillions off the dollar value of China’s GDP. According to Goldman Sachs analysts, this could shrink economic output by up to $3tn.

Market-watchers are wondering if this is a temporary funk or the sign of structural challenge. A middle-income trap looms, as does a reckoning with a shadow banking system running scared. In May, Xinhua Trust became the first Chinese shadow lender to file for bankruptcy. Since then, Zhongrong International Trust, the country’s largest, has missed a number of payments.

A Crisis Foretold

Operating largely outside the control and scrutiny of the People’s Bank of China, a 2020 clampdown on off-book lending notwithstanding, trust companies took in almost $2.7tn (RMB21tn) from (mostly) retail investors lured by the promise of annual returns of 10 percent or more. About a third of those deposits found their way, directly or indirectly, to the now ailing real estate sector. Another sizeable chunk was loaned to local governments, which are struggling to repay their estimated $7.2tn debt.

Investors have understandably been spooked by an opaque triad of trusts, property developers, and local governments. But most can’t withdraw their cash —most trust products carry terms that inhibit or prohibit early redemptions. Those conditions may yet help China to avert a banking crisis — if it starts to address its problems in earnest.

The trust issue fails to promote or sustain consumer confidence. Consumers are a fickle lot and can, as the Americans say, turn on a dime. It’s up to President Jinping to show his commitment to the pursuit of high growth — and a willingness to impose some self-restraint. But not even Jinping himself can prove that he will not change his mind yet again. He seems stuck in a web of his own making.

Yes Men

The president has repeatedly signalled his willingness to sacrifice “accelerated” growth for “quality” growth, which prepares the country for a sustained economic — and possibly even military — dispute with the US. National greatness, security, and resilience are priorities. This implies that business and politics are no longer separate issues, and must be merged towards a common end, however ill-defined they currently are.

In the past, policy errors accumulated: the sudden cancellation of the zero-Covid policy exposed fallibility. The crackdown on tech firms scared off entrepreneurs and stifled innovation. The central bank’s timid response to deflation — and its odd refusal to cut interest rates — hampers growth and dampens consumption. In the administration, technocrats are being sidetracked by party loyalists and dogma.

A storm appears to be gathering. Short-term issues coincide with unsettling long-term trends; there are concerns about the ageing population, mounting Western opposition to unbridled expansionism, and the transfer — voluntary or otherwise — of intellectual property. As the country began its remarkable ascendancy almost 50 years ago, China proved that democracy and an open society are not preconditions for rapid growth and development.

It is now finding out that centralised authoritarianism may prove detrimental to that cause.